Pretax deductions provide a savings on your annual returns. Deductions from your wages used to pay for your employer-sponsored benefits reduce your income and are excluded from taxes. In many cases, pretax deductions are exempt from Medicare tax; however, this isn’t always the case. The deduction counts as Medicare wages only if it is subject to Medicare tax.
Pretax deductions save you money on federal income tax. Some, but not all, are also exempt from Medicare tax.
Medicare Wages and Taxes
Medicare tax by definition goes to fund the federal insurance program for elderly and disabled people. It's deducted from your paychecks along with Social Security tax, which pays for that federal program, as well as ordinary federal and state income tax.
Whether pretax deductions count as Medicare wages depends on the type of deduction. Pretax benefits include those offered under a cafeteria – or Section 125 – plan, such as medical, dental, vision, life, accident and disability insurance; and flexible spending accounts such as dependent care, and health savings and adoption assistance reimbursement accounts. Also, qualified retirement contributions, transportation expenses and educational assistance may be pretax deductions.
Most of these benefits are exempt from Medicare tax, except for adoption assistance, retirement contributions, and life insurance premiums on coverage that exceeds $50,000. Also, amounts you receive for educational assistance under your employer’s program earn you a pretax deduction; up to $5,250 annually is exempt from Medicare tax.
If a pretax deduction is excluded from Medicare tax, subtract it from your gross wages before subtracting the tax. For example, if you earn $2,000 semi-monthly and pay $100 toward your pretax health insurance plan, subtract $100 from $2,000 to get $1,900, which is subject to Medicare tax. If the deduction was taxable, your entire gross pay of $2,000 would be subject to taxation. As of 2017 and 2018, calculate Medicare tax at 1.45 percent of your taxable wages. Your employer pays another 1.45 percent of your salary in Medicare tax.
Your employer puts your annual Medicare wages in Box 5 of your W-2 and Medicare tax withheld for the year in Box 6. The amount shown in Box 5 does not include pretax deductions which are exempt from Medicare tax. Your last pay stub for the year may show a different year-to-date amount for Medicare wages than your W-2. In this case, add your pretax deductions which are exempt from Medicare tax to the amount shown in Box 5 of your W-2. The result should equal the amount shown on your last paycheck stub for the year.
Social Security Tax Exemptions
Pretax deductions that are excluded from Medicare tax are typically exempt from Social Security tax as well. Your Medicare wages are usually the same as your Social Security wages except that Social Security tax has an annual wage limit and Medicare tax has none. If you have multiple jobs that collectively put you over the wage limit, you may get a refund for over-withheld Social Security tax
The Social Security tax rate is 6.2 percent payable by the employee and 6.2 percent payable by the employer. Self-employed people must pay what is called self-employment tax, which includes the employee and employer portions of Social Security and Medicare taxes, so they pay a 15.3 percent tax rate.
2018 Tax Law
Social Security and Medicare taxes aren't substantially impacted by the 2018 tax law changes. The other benefits of some deductions will change, since tax rates are generally going down. meaning deductions will deliver less tax saving to many taxpayers.
Social Security taxes apply to wages up to $128,400 as of the 2018 tax year.
2017 Tax Law
As of 2017, Social Security taxes apply the first $127,200 of wages each worker receives.
- IRS.gov: 401k Plan Overview
- Patriot Software: A Look at Qualified Pre-Tax Deductions
- IRS.gov: Publication 15-B
- Patriot Software: 4 Things You Need to Know About Taxable Wages
- IRS.gov: W-2 Form
- IRS: Publication 15-B, Employer's Tax Guide to Fringe Benefits
- Investopedia: Understanding Taxes on Life Insurance Premiums
- Paycor: 2017 Social Security Taxable Wage Base Announced
- Journal of Accountancy: Social Security Administration Announces Small Increase in 2018 Wage Base
- The Motley Fool: How Do I Claim a Social Security Tax Refund?